Succession Planning Basics

Succession Planning Basics

For many baby boomers, the time is fast approaching when crucial decisions need to be made about passing on, or selling, the family business. Equally important in many circumstances is the appropriate planning surrounding family-held real estate, whether it be a summer home or otherwise. Here are some basics to be considering.

The Family Business

Most family businesses are small, closely held operations. The founder, or perhaps the current owner if a generation has already come and gone, often struggles with what to do with his or her life’s work and effort. Many business owners don’t really want to “cash out” if there is a viable option for keeping it in the family or among a close circle of employees. The key is to start early and evaluate all of your options often!

Non-voting stock strategy

For business owners who want to pass the business operation on to children, either through outright gift, an advantageous sale, or a combination of both, there are a variety of strategies to consider. If the business is a subchapter C or subchapter S corporation, one frequently used strategy is to create a new class of non-voting stock. This allows the stock to be valued at a lower price per share because it does not have voting power. This is advantageous for both gifting and sale at less than full value.

Further depreciation in value can result from applicable “discounts” as a result of a gift of less than a majority of stock (not being able to control the entity) and for “marketability” (because such shares have a reduced value on the open market). A further benefit is that the managing owners can retain voting control for a longer period of time.

The crucial question here is whether the owner wants or needs to receive full value for the shares of stock that are being passed along. Practically speaking, interfamily transfers seldom result in the owner receiving full value – only a sale on the open market will result in that.

ESOP strategy

If the owner has no family that wishes to or is capable of continuing on the business, then another option is to sell the business to some or all of its employees through a vehicle commonly known as an ESOP (Employee Stock Ownership Plan). This will likely be the subject of a whole separate blog post because of its complexity. Suffice it to say that an ESOP can be an effective tool if one has great confidence in senior non-family management of the company and its prospects under their direction.

Family Real Estate

Succession planning is equally important in forging successful transitions from one generation to the next for family-held real estate. Typically, a summer home was built or bought by parents or grandparents. The baby boomer generation grew up in those homes and usually have nothing but the happiest of memories about time spent there. Now, when the “big kahunas” are gone from the scene, and ownership had evolved to second, third and sometimes fourth generations, these situations usually become fraught with difficulties and unhappiness. As Drew Anderson noted in an earlier blog post, one of the best strategies for dealing with and transferring ownership in multi-generational situations is the family LLC. Never put family-held vacation real estate into a corporation of any kind! In some situations, however, a family trust can be appropriate.

I have had situations where owners of vacation property, usually in the first or second generation, wish to tie up the property in perpetuity in the family. This is usually driven by the best of intentions — family memories and bonds can run deep around such properties! The problem, of course, is that as the generations move on, the numbers of owners of ever smaller interests will increase, and at least some of those owners will have no interest in the property other than as a financial asset or, conversely, as a free vacation.

When structuring the governance provisions of whatever vehicle is used to hold title to the property, there needs to be an “escape valve” for buying out those who no longer wish to own any interest in the property. This will usually include a steep discount, as well as the ability to “freeze out” those who refuse to contribute to ongoing maintenance and upkeep, even though they wish to continue to use the property.

The bottom line is that clarity in governance provisions is essential. Otherwise, no matter what structure is selected, family strife and discord can result. Open, frank and thoughtful discussion between the owners is essential. So much the better if it can be guided by experienced counsel.